MACRO AND MARKETS, TRADE FINANCE, CASH MANAGEMENT
Towards a silver lining
03 April 2020
While the Covid-19 pandemic extends its grip, analysts are already assessing the impact and cost of what could be around US$5trn in fiscal support, and economies taking lessons from the global financial crisis on how to emerge fitter for business from this pandemic. flow's Clarissa Dann reports
As the global economy continues its freefall and the GDP peak-to-trough gap looks set to be twice the width of that seen during the Global Financial Crisis, observers have their eyes on what some form of “new normal” might look like once the world ventures out of lockdown and begins its recovery.
“When one of the world’s economic giants sneezes, the rest of the world catches a cold. Now everyone is coughing,” noted The Economist on 28 March, reflecting on how the perfect storm of trade wars, border closures, factory shutdowns, a slump in global demand and dislocated supply chains is on track to take a large bite out of the estimated US$25trn of goods and services global trade flows.
Scale of contraction
Having triggered the largest contractions of economic output since World War Two, the current and prospective containment measures being taken to combat Covid-19 in the Euro Area and the US are, reported Deutsche Bank analysts “depressing the levels of consumer and business spending by more than anything we have seen since the Great Depression of the 1930s”.
In their report, Impact of Covid-19 on the global economy: Beyond the abyss (30 March) Deutsche Bank’s Global Head of Research David Folkerts-Landau and his team reflect on how the Fed and the ECB have deployed their huge fiscal programmes to “sharply reduce the risk of falling into another Great Depression 90 years on.”
They note that the 2008 crisis had “prepared them to take critically important measures quickly to instil liquidity and confidence in financial markets” and that the fiscal measures are now “targeted at forestalling a much deeper drop in aggregate demand that would otherwise occur, holding economic infrastructure together well enough to allow a much easier recovery than would otherwise occur when the time comes”. OECD Secretary-General Angel Gurría drives home the point, “Millions of deaths and collapsed health care systems will decimate us financially and as a society, so slowing this epidemic and saving human lives must be governments’ first priority.”
Figure 1: Potential initial impact of partial or complete shutdowns on activity in selected G7 economies
OECD estimates show the lockdown will directly affect sectors amounting to up to one-third of GDP in major economies, predicting that each month of containment means a loss of two percentage points in annual GDP growth. It makes the point that even once these measures begin to be eased, “the extent of any subsequent recovery in output will depend on the effectiveness of the policy actions taken to support workers and companies through the downturn and the extent to which confidence returns”.
Once we get out on the other side, investors may again begin to look at countries and rank them according to the size of not only government debt levels but broader debt levels including the private sector
Debt mountain ascent
Figure 2: Global debt as a share of GDP unchanged since 2009
More importantly, said Folkerts-Landau and colleagues in Impact of Covid-19 on the global economy, is the fact that the massive fiscal packages “will have to be paid for eventually one way or another”. This means that unprecedented cooperation between fiscal authorities and central banks “could be needed for some time”. At any rate, sheer mathematics points to the inevitability of rises in sovereign risk premiums and taxes, not to mention inflation over the longer term. “This is true even in the US where a day of reckoning will eventually come as public debt levels continue their impressive ascent. For the time being, the enormous size of central bank intervention will distort price discovery in most credit and rates markets, creating a problem that will only emerge in the future,” they reflect.
The other issue is how long governments can keep up the support, a point made by Deutsche Bank’s Cross-thematic research team in The exit strategy (31 March), who note “Another risk concerns the ability of governments to maintain their stimulus levels if containment measures have to be continually reinforced. Some governments may lose the ability to borrow at sustainable rates. In this case, they may be forced to either reopen their economy against medical advice, or create an unsustainable debt loop.”
They continue, “As a minimum central banks will be forced into more government bond buying with the consequences highly uncertain over the medium to longer term. In particular Europe risks an extreme political crisis if southern economies are not offered significant financial solidarity to fight the virus.”
Global sectoral debt has been rising steadily for the past three decades, with a clear acceleration at around the time of the previous crisis in 2009 with a levelling off in the decade that followed. According to the Institute of International Finance’s Global Debt Monitor, global debt, which comprises borrowings from households, governments and companies grew by US$9trn to almost US$253trn during the first nine months of 2019, putting the global debt-to-GDP ratio at 322%, overtaking 2016 as the highest on record (see Figure 2 above).
And this was before Covid-19 struck, along with its US$5trn of G20 fiscal spending to “do whatever it takes to overcome the pandemic”, as leaders put it in their virtual emergency summit on 26 March.
When doors are closed the corporate sector has much lower revenue and workers have much lower incomes. As a result, a government has to step in and replace that income by giving grants or loans to companies and workers, explains Torsten Sløk, Chief Economist at Deutsche Bank Securities in an interview with flow. This, he adds, has to be financed and the result is more government debt issuance, which further increases an already significant amount of government debt outstanding in a number of countries, most prominently the US.
An alternative way to raise money is for corporates to issue bonds that raise cash to keep them afloat through an extended lockdown. This raises the level of debt in the corporate sector. Similarly, households may have to increase debt levels; for example if workers lose their jobs because of the virus.
Is all this sustainable? Sløk reflects, “For the time being there is little worry in markets about sustainability of government finances in the US but, once we get out on the other side, investors may again begin to look at countries and rank them according to the size of not only government debt levels but broader debt levels including the private sector.”
Outlook for trade
After the 1918 pandemic flu, the Dow Jones saw a 33% correction and a muted rebound. Trade bounced back rather quicker after the 2009 financial crisis, with the former World Trade Organization (WTO) Director General Pascal Lamy having called upon export credit agencies, development and commercial banks to “promote their greater involvement in trade finance activities, as a sort of lifeline for their economic activity in many countries.” How it will fare this time around, with Brent having plunged almost 75% in Q1 to a 19-year low of US$17.9/bbl, remains to be seen – Platts reported on 1 April that “despite the cheap crude, refineries were concerned that low international product prices could hit their economics”.
The WTO and International Chamber of Commerce (ICC) have called for community action again. On 2 April, WTO Director General Roberto Azevêdo and International Chamber of Commerce Secretary-General John Denton issued a joint statement requesting more dialogue with business to maximise the effectiveness of public policies that mitigate the economic damage resulting from the Covid-19 pandemic, particularly with regards to trade.
“It is increasingly clear that the economic downturn caused by the pandemic will necessitate a significant rebuild of domestic policies – and of international cooperation,” they said. “Ongoing efforts to improve and strengthen the global trading system, including the WTO, must therefore continue.”
Learning points, rebounds and silver linings
A common theme across the latest round of economic analysis is comfort in the fact that leaders have been through previous financial crises and learned how to “support today” so that everyone can do business tomorrow. In his April 2020 review of global responses Deutsche Bank Securities’ Capital Markets Strategist, Tom Joyce, observes how quickly the US$2.4trn Coronavirus Aid, Relief and Economic Security package the CARES Act was put together (one to two weeks) and the fact in an election year “support in the US Senate was unanimous across both sides of the aisle with a 96-0 vote”.
US Coronavirus Aid, Relief and Economic Security (CARES) package
While the economic shock underway is “larger” than the global financial crisis in both speed and magnitude, the bounce back after virus containment should be more rapid, reflects Joyce: “The origins of this shock are not balance sheet-driven as in 2008, but rather, are more income based through a demand shock. The fiscal and monetary response underway has also benefitted from the 2008−9 roadmap, and is the largest in history.”
Governments are learning and adjusting as the pandemic takes hold, adds Joyce. So while the virus response was initially slow across the US and Europe, it has progressed significantly over the last two weeks across many countries. “Social distancing and quarantines (where needed) have been established across most high population regions. Testing still lags in the US in particular, but is ramping up in New York, and will soon in other regions. Healthcare protective gear (PPE), ventilators and bed capacity are all receiving significant, if not belated, attention and resources.”
What should not be forgotten, he concludes, is that society has been fundamentally altered by the largest global health pandemic in a century. “People and communities are coming together, albeit virtually. Families are spending uninterrupted time at home in a manner similar to generations past. Digital and technology based adoption has skyrocketed, as has the related social creativity and entertainment. The environment is having a much needed breath of fresh air. And while too many people have needlessly become sick or died, the human spirit has been strengthened.”
Summary of Deutsche Bank Research reports referenced
- Impact of Covid-19 on the global economy: Beyond the abyss (30 March 2020) by David Folkerts-Landau, Peter Hooper, Mark Wall, Matthew Luzzetti, Michael Spencer, Stefan Schneider, Yi Xiong, Kentaro Koyama, Torsten Sløk, Juliana Lee, Binky Chadha, Jim Reid, Francis Yared, George Saravelos, Justin Weidner, Surav Dasgupta, and Kuhumita Bhattacharya
- The exit strategy (31 March 2020) by Luke Templeman, Jim Reid, Marion Laboure, and Henry Allen
- Global Macro Outlook: Uncertainty about the coronavirus, the policy response, and the election (April 2020) by Torsten Sløk
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